Reaganomics

[Heid the Ba]

From The Onion.

[Arneb]

I looooove the Onion.

Funny, I always wanted to ask this question to our resident ecoomist: What exactly was Reagonomics, and how is it viewed today in the economics community?

(This time, serious please).

[Мастер]

I looooove the Onion.

Funny, I always wanted to ask this question to our resident ecoomist: What exactly was Reagonomics, and how is it viewed today in the economics community?

(This time, serious please).

If that's a reference to me (not sure who else it would be), I wouldn't use that word to refer to myself these days, although I would have at one time; certainly I wasn't a macroeconomist. But I'll go ahead and give an answer, whether it was for me or not :P

Reagan was generally regarded as a charismatic leader rather than a towering intellectual giant, and didn't have much (any?) training in economics. The term Reaganomics was used to describe any one of a number of oft-repeated aphorisms (or non-aphorisms, accordingly) he would utter.

Probably the best-known, and the one that might be said to sum up the essence of Reaganomics, was his believe that tax cuts would increase revenue. Here is an article about the Laffer curve, although as noted, Arthur Laffer didn't invent it. The basic idea is certainly non-controversial. If the tax rate is 0%, then tax revenues will be 0%, and if the tax rate is 100%, then tax revenues will also be 0%, because nobody would do any work if all of their pay is taxed away. Somewhere in between, there is a tax rate that results in maximum tax revenue. The controversial part is Laffer's claim that the US at the time had tax rates that were above the revenue-maximizing rate. I don't think this idea is widely accepted, and the fact that large deficits occurred in the 1980s and 1990s, taking the tax hikes of George H. Bush and Bill Clinton to final bring the federal budget back into balance 20 years later, seems to support the idea that the US was not in a situation where lowering tax rates would increase tax revenues :P

People also talk about Reaganomics as if it meant greatly reducing the size of the welfare state, and Reagan's speeches would support that. However, one of the more interesting features of this so-called "Reagan Revolution" is that it never took place; government spending on these things grew at a slower rate, but it certainly didn't shrink.

Another aspect of the deficits of the Reagan years was that they were at least partly pre-determined. Large increases in government spending programs basically on auto-pilot could have been (and were) forecast in the 1970s, before anyone knew Reagan was going to be president. That said, he certainly didn't do anything to restraint them; he had significant tax cuts passed, did not make corresponding cuts in social programs, and also significantly increased military spending. So I don't think he created the deficits of the 1980s, although he made them worse.

If the above argues that Reagan got blamed for something that wasn't entirely his own fault, I would say he also got credit for things he wasn't entirely responsible for. The economic expansion of the 1980s was the longest in the US since the second world war, until the expansion of the 1990s, mostly under Bill Clinton, lasted longer. But I would argue that there is more going on here than the specific policies of individual countries; these things tend to be trans-national, countries with left-wing and right-wing governments alike sharing in the prosperity (or the pain), and people in those countries arguing that the specific left-wing or right-wing policies of their own governments are somehow responsible for a largely global phenomenon. One could be tempted to argue that the trickle-down economics of Reagan (tax cuts on the wealthy result in general economic growth that benefits all) did work, as the 1980s had much better economic growth than the 1970s, and after a sharp recession in the early 1980s (along with controversy about deployment of nuclear missiles in Europe, making Reagan so unpopular at the time that he thought about not running for a second term), by 1984 he won 49 out of 50 states. But again, I would argue that to do so would be to credit the national policies of one country with a phenomenon that is at least partially globally driven...

Well, that's my $0.02 Canadian...

[Arneb]

My most sincere gratitude, KOS! I learmed a lot from this.

I remember a "Der Spiegel" title page from the early 80s showing Reagan amid the archetypical American extended family on a presumably huge farm sharing a giant Turkey, proclaiming "Reagan's America - America of the rich". In Europe, you can say he remained unpopular up until the end of his second term.

[Heid the Ba]

In the UK the term was usually used as short-hand for lower taxes, not necessarily for economic reasons but for the political reason that individuals spend more effectively and wisely than governments.

I don't remember Reagan being unpopular here, certainly not as unpopular as GWB; of course we had Maggie Thatcher who did an excellent job of polarising opinion.

Good summary KOS, thanks.

[Мастер]

Well, thanks guys, glad you liked it :) The usual result of talking about Reagan is to start a vicious flame war :(

But, what a coincidence, I mention Arthur Laffer in the context of Reaganomics, and here he is defending it:

http://www.msnbc.msn.com/id/21266703/

He is the second responder to the question.

[Dragon Star]

Current U.S. economy doing great? Boy, Paracelsus won't like this... :P

[Enzo]

I remember trickle down. These days it refers to the drool at he corner of my mouth, but that is another story.

As I understand trickle down, it means they cut my taxes, so I then turn around and buy my daughter a dog grooming business for her bithday, and she hires your son at minimum wage part time. to watch the store while she shops for new clcothes at the mall with her friends.

[Heid the Ba]

But, what a coincidence, I mention Arthur Laffer in the context of Reaganomics, and here he is defending it:

There are a lot of dubious statements in there, mixed with hyperbole. But then what do I know, I just live in awe of the US economy and wish I had it as good as any American.

[Мастер]

I just live in awe of the US economy and wish I had it as good as any American.

Well, it is largely a haggis-free environment over here :P

[Arneb]

Yes, I can't stop crying about the fact that I don't live there

[Heid the Ba]

I just live in awe of the US economy and wish I had it as good as any American.

Well, it is largely a haggis-free environment over here :P

[Enzo]

Oysters Rockefeller

Veal Oscar

Haggis Sophia

[Heid the Ba]

Haggis Sophia

As a byzantinist I have to applaud your link of my national dish with the Mother Church. The most impressive thing about it is not the dome and main area, you expect that; it is the size of the galleries which are the showstopper. And let's not forget that the minarets are 500 years old but still 1000 years newer than the main church.

Of course the Byzantine economy wasn't up to much either . . .

[Arneb]

Of course the Byzantine economy wasn't up to much either . . .

Of course not. It wasn't American, so how could it? Duh.

[Enzo]

it is not the dome and main area, you expect that; it is the size of the galleries which are the showstopper.

But you have to admit, it is a major domo.

[Мастер]

In Europe, you can say he remained unpopular up until the end of his second term.

Meaning he became popular at that time, or everyone just forgot about him once he was out of office? :P

My anecdotal recollection (didn't do a fact check on this) was that the Iran-Contra scandal of his second term significantly dented his popularity. Not enough to sink his vice-President George H. Bush in the 1988 election though.

One of life's rather strange ironies is that Reagan's popular vote count in 1984 (recognizing that popular vote count is not the way presidents are selected in the US) was not exceeded until 2000, by both Al Gore and George W Bush, with the loser having slightly more votes than the winner...

Bill Clinton might have topped Reagan's count if there wasn't a third-party challenger in both of the elections he won. Although I do know a number of people who are convinced that George H Bush would have won reelection in 1992 if the third-party challenger hadn't run. They don't have evidence like polls to support this; the evidence seems to be that that's what they wanted to happen, so it must be true...

[Arneb]

Meaning he became popular at that time, or everyone just forgot about him once he was out of office? :P

:D

Come to think about it, that's probably how it went. The end of Reagan's administration was bathed in a mild light with encouraging rapproachment between the superpowers, nuclear disarmament treaties, and so on. Everybody here forgot about Reagan when the wall came down and unification craze ensued. When we looked back, Reagan was a lot more popular then during his days of office when he was mainly identified with Bitburg cemetary visit, the "evil empire" speech and "take form the poor, give to the rich".

[Blue Monster 65]

Bonzo Goes to Bitburg ...

I dunno - the thing I got from Reagan (other than a headache) was the lesson that DEFICITS DO MATTER, regardless of how everyone in Washington and all the wannabes want to say they don't.

KOS, you may feel free to tell me how I'm wrong.

Woof! - Scott

[Мастер]

I dunno - the thing I got from Reagan (other than a headache) was the lesson that DEFICITS DO MATTER, regardless of how everyone in Washington and all the wannabes want to say they don't.

KOS, you may feel free to tell me how I'm wrong.

Matter to whom, and relative to what?

This is a well-studied question, but one people still debate; there was a session at the annual meeting of the American Economic Association on this topic a few years back. How do people react to deficits?

Holding government spending fixed, they can pay for it all through taxation, or by borrowing, which is effectively future taxation. If the government chooses the latter course, then it all depends on how the public reacts. If they recognize that they will be taxed in the future to pay for the current spending, and set aside savings in anticipation of this need, then there is no net effect on the real economy. It's all bookkeeping. Instead of the government taking the money now, they borrow it from the people they would have been taxing. They pay it back in the future with interest, and then raise the same amount through taxation, leaving everyone in exactly the same position they would have been if the government just taxed them in the first place.

This principle is called Ricardian equivalence. If people do not behave in this way (and nobody really believes they do completely, the question is how significantly they deviate from the Ricardian equivalence behavior), then running a deficit (relative to having no deficit and higher taxation) definitely has an effect on the real economy. Savings is lower than it otherwise would have been, and consumption is higher.

Raising taxes is one way to eliminate a deficit. The other is to cut spending. Relative to this scenario, it's pretty clear that there is an effect on the real economy; government spending is different, and that's a real effect.

So I guess my questions would be:

a) When you say that the deficits matter, which alternative scenario are you comparing the situation to - one in which the deficit is eliminated through higher taxation, or through lower government spending? (Or perhaps a mixture of both?)

b) What are the effects you feel followed from running the deficit instead of the alternative you propose in a)?

[Blue Monster 65]

I would have to say I believe in cutting spending and lowering taxes. Mind you, in a war situation, I believe in both cutting spending and raising taxes! But that requires belt-tightening on the part of the public and a close eye on war profiteering, which we are NOT doing.

I would also say that the current deficit is helping devalue our dollar against other currencies, thereby helping push us further into recession.

Mind you, this is quite simplistic compared to what I'm sure you can present, but from the articles I'm reading, our weak dollar - partially the result of our massive deficit - is leading to much less spending power for us. See here: http://www.bloomberg.com/apps/news?pid= ... refer=home Perhaps I'm reading too much into this, but I think it's a prime example.

Again, feel free to edumacate me!

Woof! - Scott

[Мастер]

I would have to say I believe in cutting spending and lowering taxes. Mind you, in a war situation, I believe in both cutting spending and raising taxes! But that requires belt-tightening on the part of the public and a close eye on war profiteering, which we are NOT doing.

OK, so in the non-war situation that prevailed for most of the 1980s (unless we count the cold war), you would have preferred that both taxation and spending (set at the same level, to eliminate the deficit) would be lower than the level of taxation actually was during this period? That would be a significant reduction in government spending, which unquestionably has a direct effect on the real economy. I think it is completely non-controversial that things would have been different in that scenario.

What is more debatable is whether, holding a level of spending fixed, the manner in which one finances the spending (through current taxation, or through a deficit, which is effectively future taxation) matters in a significant way. So if we have three scenarios:

A: Government spends $100, taxes $80, runs deficit of $20.
B: Government spends $100, taxes $100, runs deficit of $0.
C: Government spends $80, taxes $80, runs deficit of $0.

Nobody questions that scenario C has different implications than A and B. What people disagree on is whether the implications of A and B are all that different.

We could consider the two extremes of how the public may react to the deficit in Scenario A, which we can call A1 and A2:

A1: If, in scenario A, the public saves $20 more than they would have in scenario B, and lends it to the government, then in the future, the government pays back the $20 (plus interest) with one hand, but reclaims it in taxes with the other. In this case, the effect of the deficit in scenario A (relative to scenario B - nobody questions that it's different than scenario C) would be absolutely nothing on anything. Everyone knows that because the government has already spent that $20, they're going to come for it one day, and they set it aside (and in fact lend it to the government to finance the deficit). The difference between scenario A and B is then that in Scenario A, the public has a piece of paper from the government that says "I owe you $20", but they know it is not for real, since the government will tax them to pay off the debt. So the net effect of the deficit is zero.

A2: If, on the other hand, the public reacts to the $20 tax cut they receive in Scenario A (relative to Scenario B) by saying, wow, our taxes are lower, let's have a $20 party, not worrying about the fact they will eventually get taxed $20 to pay off the government debt, then this will have all kinds of effects. Private consumption will be $20 higher, and private savings/investment will be $20 lower (since $20 that was available for private investment is now borrowed by the government instead). Here, there are clear differences in the real economy, depending on whether government spending is financed through current taxation, or through borrowing, and these differences occur because the public does not rationally anticipate that their taxes will be higher in the future, and save money so they can pay them.

So the million dollar question is, does the public act more like Scenario A1, or more like A2? In the usual favored macroeconomics of the political left, they act like A2 (deficits matter), the newer macroeconomic school more commonly associated with the political right has a public that acts more like A1 (deficits don't matter). It seems like this should be a question of fact that can easily be answered by looking at the world, but this is one of the difficult things about a field like economics; it's not a laboratory science, where you can change one variable and observe its effects. All you get to see is the evolution of the real economy, in which many many variables are all changing at the same time, and it can be quite difficult to disentangle their effects.

Although I draw a link between the two schools of macroeconomic thought and political orientation in the previous paragraph, this association is messy, imperfect, and politicians are often grossly inconsistent on this point. To wit, the tax cuts of GWB's first term were partly sold as stimulative (economy slowed through much of 2000 and tipped into recession right about the changing of the guard). If you argue that tax cuts (holding sending fixed) stimulate the economy, then you have to believe in scenario A2. If you believe in scenario A1, then the public will not increase their consumption. But it's talking out of both sides of the mouth to say that you can use a deficit to bring the economy out of recession (a move straight out of the playbook of John Maynard Keynes, and one that would normally be associated with leftish politics, but here on offer by GWB), and then to argue that the accumulated debt has no effect. Well, you can argue one way or the other with a straight face, but not both - they're inconsistent.

The traditional Keynesian macroeconomics (born of the great depression, which according to classical macroeconomics couldn't happen) has in its toolkit the idea of running a deficit to stimulate the economy during slow times, and then paying off the accumulated debt during the good times. This is often misinterpreted by politicians and the public alike to mean that the government should always run a deficit to stimulate the economy. That doesn't work, Keynes' idea was that you could smooth out economic cycles this way, not permanently up the rate of growth through deficit spending. Franklin Delano Roosevelt practiced this with zeal, although there are debates about whether the New Deal programs were really carried out on a big enough scale to make much of a difference. Keynesian macroeconomics is more typically associated with the political left, but, as noted above, GWB often borrows from this playbook, as do many other politicians who are usually thought of as conservative. At the heart of Keynes' thinking here is the idea that people behave as in scenario A2. If they act like A1, then Keynes' ideas don't work.

Neoclassical macroeconomics is the newer school, and tries to repair classical economics so that extended global depressions (not possible in the original version) can occur, spurred by the observation that one actually did occur. It is usually associated with the political right, but not always - see above. The neoclassical assumption will normally be that people behave as in A1, and, holding spending fixed, deficits ought not to matter. Many more rightist politicians don't seem to grasp this though; in the US, "cut taxes" seems to be the mantra of the right, but if you don't cut spending as well, all it means is that you have to raise taxes in the future. So I think many rightist politicians haven't read their own playbook.

I would also say that the current deficit is helping devalue our dollar against other currencies, thereby helping push us further into recession.

Agh, I'm getting tired here :P Let me just say in a grossly oversimplified way that you might expect a weakened currency if you believe in scenario A2, although it depends on other things as well. But why does weak currency push you into recession? It makes imports more expensive, and exports less expensive (to the people in the other country). A country whose currency has weakened should find products manufactured in its country are more competitive against foreign products both inside and outside the country.

The US economy is not currently in recession, although there are some warning signs that there may be one soon. But one of the longest economic expansions of recent history (of the 1980s) occurred through a period of sustained deficits. The only one in recent history that was longer (of the 1990s) came to an end not long after the budget was brought into balance :P

But, generally, you have to be very careful analyzing these questions. The value of the currency is determined in a market, in which forces of supply and demand operate. The currency can become weak because of changes in its supply, or in its demand. The effects of a weakening due to changes in supply can be different than one due to changes in demand. This phenomenon goes under the heading of "endogeneity," and can easily lead one astray, but in fairness, it took economists many years to figure this one out themselves :P

but from the articles I'm reading, our weak dollar - partially the result of our massive deficit - is leading to much less spending power for us.

The weak dollar does make things purchased from other countries more expensive, but that's different than pushing the economy into recession.

I guess I could go on, but I've probably already written more than anyone wants to read :(

[Blue Monster 65]

Excellent! That's probably more than I got out of my whole two semesters of Econ.

Mind you, the classes were taught by a gentleman who was here from Iran (a refugee as it were) who did not have the best grasp on the English language. He was probably too intelligent for the lot of students he was stuck with and I, a musician, wasn't really of the mind to learn that sort of thing at the time.

Since then, I've read this and that, and just paid attention as I could. Nice work on putting it all in a quick study guide, though: I do appreciate it!

And Michigan, by the way, is arguably in a recession.

Woof! - Scott

[Мастер]

Excellent! That's probably more than I got out of my whole two semesters of Econ.

Glad you found it helpful :P I'm attempting to remain strictly objective in it, and not interject my own opinion.

For what it's worth, my own schooling on this was strictly neo-classical, at what is widely regarded as a right-wing bastion. But "right-wing" seems to mean different things in economic circles and political circles; they're more into limited government and letting markets work; I didn't know anyone there who was into the guns/gays/God kind of rightism :P

After that, my circumstances were such that I came into contact mainly with left-of-center types, including one guy who scared the hell out of me. My experience in the two places gave me lifelong immunization against both rightism and leftism :P

And Michigan, by the way, is arguably in a recession.

I couldn't say for sure, but it's certainly believable. It seems like the US car companies are getting killed for making most of their money from trucks and SUVs at a time when the price of gasoline shoots up. But maybe there are other things going on in Michigan as well. But for the cars at least, a weak dollar makes the US product more competitive both in and out of the country!

[Enzo]

Actally KOS I enjoyed reading that. I appreciate a thoughful discourse on something I know little of from someone who does.